Let's talk about profit

Profitability isn’t a switch you can turn on and off. No business can suddenly decide that it’s time to get profitable and implement a strategy. If businesses aren’t structured to be profitable, the only real strategy an entrepreneur can implement is to cut costs, almost always at the expense of growth. Profitability at the expense of growth doesn’t last.

Over the past few years, many investors and entrepreneurs attempted to create value in startups purely on the back of investing large sums of money. The belief was (and in some cases still is) that the more money a startup raised, the faster it would grow, and growth alone would make it more valuable.But that’s not how long-term value is created. As an entrepreneur or an investor, if you follow this logic, inherently you are not trying to build a strong, self-sustainable business. You are trying to create short-term value, probably with the hope of flipping the business. The problem with businesses that rely purely on invested capital to drive value is that they have the propensity to fail as often as to succeed. And the Indian ecosystem has now seen plenty of examples of this mindset play out over the past couple of years.

Luckily, the conversation is changing. The ecosystem is realising that real value can only be created by businesses that generate profit. As a result, everywhere you look, you see people talking about how “it’s time startups got profitable”.

Unfortunately, profitability isn’t a switch you can turn on and off. No business can suddenly decide that it’s time to get profitable and then implement a strategy to become profitable. If businesses aren’t structured to be profitable, the only real strategy an entrepreneur can implement is to cut costs, almost always at the expense of growth. Profitability at the expense of growth doesn’t last. Nor does it create value.Can all businesses be structured to be profitable, you ask? Absolutely not. Profit is the result of a long-term business strategy that invests heavily in products and services that have, as Warren Buffett says, “wide, sustainable moats around them”. A “moat” is a fancy way of describing a competitive advantage. My favorite example of a moat is the licence raj that existed in India. Once you had that licence, you had pricing power. And that’s exactly what a moat provides: pricing power. Buffett agrees: “The key to investing is not assessing how much a company will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage.

For me (and for our fund), the venture capital business is fundamentally about helping businesses build moats.

It needs to be part of the conversation from the very beginning of a business’s existence and constantly brought up every time a decision is made, every time a change is discussed, and every time a pivot is considered. The more money a business gets, the wider that moat needs to become. The wider the moat becomes, the more profit the business should generate in future. This is the kind of profit that helps build self-sustainable businesses. And creates real long-term value.

So instead of asking when a startup will or can become profitable, the real question to ask is if startups are investing in building moats that will create profitability as they mature and grow. Unfortunately, most businesses don’t have moats and will never have one. So it doesn’t matter if they try to achieve profitability because, as I said earlier, that profitability won’t last. It won’t last because if you don’t have a moat, you will most probably compete on price. If you compete on price, you will lose on profitability. And we see that happening everyday in India.

As the startup ecosystem in India starts maturing, it’s crucial to make the conversation around profitability a part of the culture. It will be difficult to salvage older businesses that rely on new capital to survive, without having invested early enough on a moat. But there is an opportunity to help build new businesses that have a better opportunity to create long-term value, based on the strength of their business model and especially the durability of their moat.

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